Transitioning from Employee to Shareholder: Businesses and Individuals Need to Pay Careful Attention to Noncompete Agreements

Companies routinely require employees to sign noncompete agreements. But what happens to these employee noncompete agreements if your company offers that same employee stock options or other opportunities to acquire an ownership interest in the company?

As explained below, when an individual transitions from employee to owner or plays the dual role of employee/owner, companies need to carefully examine the impact on applicable noncompete and stock-ownership agreements in order to avoid unintended consequences.

Individual Going from Employee to Owner Under Stock Option Plan.

Consider for example a recent Michigan Court of Appeals decision involving a one-time employee in a Michigan closely held corporation. The employee, Quinlan, obtained company stock pursuant to an employee compensation plan during his employment with Landscape Forms, Inc.

The stock purchase agreements Quinlan entered into contained noncompetition provisions restricting Landscape shareholders from competing with Landscape for a five-year period after ceasing to be a shareholder. After his employment ended, Quinlan was permitted to retain his stock.

An eventual lawsuit between Quinlan and his former employer was filed that involved a number of different legal issues. One such issue relevant to this article and that should cause business owners to carefully examine their current employee stock ownership programs involved the enforceability of the of the noncompete agreement that Quinlan had entered into as part of his stock acquisition.

Differences Between an Employee Nonncompete Agreement and a Shareholder Noncompete Agreement.

Returning to the Quinlan case, the employee contended that the noncompetition agreement he previously entered into was not enforceable under Michigan’s noncompete statute (MCL 455.774a). One particular advantage that employers have under Michigan’s noncompete statute is that if an employee noncompete agreement is found to be unreasonable, a court may “limit [an] agreement to render it reasonable in light of the circumstances in which it was made and specifically enforce the agreement as limited” after it has been revised by the court.However, for various strategic reasons I do not recommend employers relying on a court to revise an unenforceable noncompete agreement.

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The Court of Appeals, however, disagreed with the the trial court’s finding that the noncompetition provisions were employer-employee agreements and therefore specifically governed by Michigan’s noncompete statute. Instead, the Court concluded that the stock purchase agreements containing the noncompete restrictions were made between the company and the shareholders – not the company and employees. Accordingly, Michigan’s noncompete statute was not applicable and the lawsuit was returned to the trial court to evaluate certain issues relative to the noncompete agreement, including when Quinlan ceased being a shareholder.

The Take-Away for Employers and Employees

For Michigan business owners interested in offering employees with stock options or other deferred compensation, many issues must be considered. In addition to the financial issues, business owners need to focus how such options may affect personnel policies and employment agreements, including noncompete agreements.

As the above case illustrates, employee noncompete agreements and shareholder noncompete agreements will be treated differently. Based on experience, such differences can provide employers with significantly more advantages than may otherwise be available under an employee noncompete agreement and correspondingly significantly more restrictions for the individual.

For these reasons, both employers and employees should consult with an experienced noncompete and business lawyer before entering into an employee stock option or ownership agreement. Feel free to contact Jason M. Shinn for information about these issues.

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